005 Ch11 class notes

005 Ch11 class notes - Outline of this chapter Combine...

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10/22/2010 1 0 CHAPTER 11 Aggregate Demand II Outline of this chapter Combine goods and money markets to look at the impact of various shocks on the equilibrium values of real interest rate (r) and real income (Y) Derive AD curve from IS-LM Model Great Depression(s) 1 CHAPTER 11 Aggregate Demand II Can you find the slope of the IS curve for the following economy? Assume that the consumption function is given by C = 200 + 0.5(Y – T) and the investment function is I = 1,000 – 200r, where r is measured in percent, G equals 300, and T equals 200. Yes. Substitute for C, I, and G in the equation Y = C + I + G and then write an equation for r as a function of Y. Slope of the IS curve will be the coefficient of Y .( –0.0025 ) 2 CHAPTER 11 Aggregate Demand II IS curve Y r r=7-0.0025Y 3 1600 If r=4, Y=1600 S=400, I=200 (not an equilibrium) If r=2, Y=1600 S=400, I=600 (not an equilibrium) In equilibrium, S=I=400
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10/22/2010 2 3 CHAPTER 11 Aggregate Demand II IS curve Y r I=S S>I S<I 4 CHAPTER 11 Aggregate Demand II Find the slope of the LM curve for the following economy. Assume that the equilibrium in the money market may be described as M/P = 0.5Y – 100r, and M/P equals 800. The slope of the LM curve is 0.005. 5 CHAPTER 11 Aggregate Demand II LM curve r = –8 + 0.005Y. 1
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10/22/2010 3 6 CHAPTER 11 Aggregate Demand II LM curve Y r M s /P=L(r,Y) M s /P<L(r,Y) M s /P>L(r,Y) 7 CHAPTER 11 Aggregate Demand II The intersection determines the unique combination of Y and r that satisfies equilibrium in both markets. The LM curve represents money market equilibrium. Equilibrium in the IS - LM model The IS curve represents equilibrium in the goods market. ( ) ( ) C Y T I r G ( , ) M P L r Y 1 8 CHAPTER 11 Aggregate Demand II Policy analysis with the - model We can use the IS-LM model to analyze the effects of fiscal policy: G and/or T monetary policy: M ( ) ( ) ( , )
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10/22/2010 4 9 CHAPTER 11 Aggregate Demand II causing output & income to rise. IS 1 An increase in government purchases 1. IS curve shifts right Y r LM 1 by 1 MPC G 2 1. 2. This raises money demand, causing the interest rate to rise… 2. 3. …which reduces investment, so the final increase in Y 1 is smaller than 1 MPC 3. 10 CHAPTER 11 Aggregate Demand II 1. A tax cut Consumers save (1 MPC ) of the tax cut, so the initial boost in spending is smaller for T than for an equal G and the IS curve shifts by MPC 1 MPC T 1. 2. 2. …so the effects on r and Y are smaller for T than for an equal G . 2. 11 CHAPTER 11 Aggregate Demand II 2. …causing the interest rate to fall Monetary policy: An increase in M 1. M > 0 shifts the LM curve down (or to the right) 3. …which increases investment, causing output & income to rise.
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10/22/2010 5 12 CHAPTER 11 Aggregate Demand II Interaction between monetary & fiscal policy Model: Monetary & fiscal policy variables ( M , G, and T ) are exogenous.
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This note was uploaded on 03/29/2011 for the course ECON 101 taught by Professor Medison during the Spring '11 term at MedU Ohio.

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005 Ch11 class notes - Outline of this chapter Combine...

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